Banks pay fines, but nobody goes to jail

I posted on this before. The Department of Justice was prosecuting banks for rigging the foreign exchange markets, and now banks agreed to pay fines, more than a billion for Citigroup and J.P. Morgan-Chase.

Fines now have exceeded 200 billion as a result of illegal activities, but nobody yet went to jail. Impunity persists. Full story here.

Mariana Mazzucato on the state and innovation

Not a huge fan of TED talks (quite the opposite indeed). But this one is well worth your time. Turns out that the great innovative entrepreneur of Schumpeter dreams is the Leviathan of his nightmares. Oh well.

Rethinking wage vs. profit-led growth theory with implications for policy analysis

By Thomas Palley

The distinction between wage-led and profit-led growth is a major feature of Post-Keynesian economics and it has triggered an extensive econometric literature aimed at identifying whether economies are wage or profit-led. That literature treats the economy’s character as exogenously given. This paper questions that assumption and shows an economy’s character is endogenous and subject to policy influence. This generates a Post-Keynesian analogue of the Lucas critique whereby the econometrically identified character of the economy depends on policy rather than being a natural characteristic. Over the past twenty years, policy has made economies appear more profit-led by lowering workers’ share of the wage bill and tax rates on shareholder income. Increasing workers’ wage bill share increases growth and capacity utilization regardless of whether the economy is wage-led, profit-led or conflictive. That speaks to making it the primary focus of policy efforts.

Read rest here.

PS: Tom's paper is in the standard Kaleckian approach in which investment is a function of capacity utilization and some measure of profit (rate or share; both are related). The so-called Kaleckian model suggests that investment is to some extent autonomous (independent of income) and not simply derived demand. With Esteban Pérez we have criticized the Kaleckian (not Kalecki, which did not develop these family of models, which are in effect a result of Joan Robinson's model) here. In our view, the distinction between profit and wage-led in a model with an independent investment function is problematic. In a sense, although we have a different (Kaldorian, based on the supermultiplier) modelling strategy, we agree with Tom's conclusion, namely: the system only appears to be profit-led, since "increasing workers’ wage bill share increases growth and capacity utilization." That's unambiguous, and should be a policy goal.

The Global Crisis of Capitalism

 

Next Week in New York at the John Jay College

Money supply, inflation and velocity

Grading. Slow posting as a result. Reading lots of replies on the Triffin Dilemma (more on that later). Interestingly many students, following the textbook (Montiel's International Macroeconomics) suggest that printing dollars was a way of dealing with the dollar shortage problems of the 1950s, as if the Fed was concerned with international liquidity problems when deciding on monetary policy. At any rate, several also suggest that money printing leads to inflation (no qualifier, like the economy must be at full employment, or something like that). Figure below for recent times.

As can be seen the huge increase in money supply basically led to a reduction of the velocity of circulation. That's why inflation has been tame, and yes we are not at full employment (we rarely are). Back to grading.

James Galbraith on Effective Governance To Spur Innovation

The United States’ deep political polarization is blinding the nation from seeing what it takes to create an effective innovation economy.

UNCTAD report shows the size of austerity

The last Trade and Development Report has been published a while ago. As always, a must read. The graph below shows the change in real government spending and also compares the actual real government spending with long-term government spending growth.

The report says: "on the whole, governments in developed countries adopted contractionary fiscal stances from mid-2010 to the end of 2013, when compared with the long-term trend." My only surprise was that France is not in the austerity group. The European periphery, and the US, are actually leading the austerity effort.

PS: In the US spending peaked in the 3rd quarter of 2009, and then it has been basically contracted ever since (here).

Unemployment down to 5.8 percent

Employment rose by 214,000 in October, and the unemployment rate fell to 5.8% according the last BLS report. The good news is that the labor force participation rate didn't change much since April. 

Hence, the employment-population ratio edged up to 59.2 percent in October, as can be seen above. Yep, still really low.

Some thoughts on currency crises and overshooting

So I've been teaching an international finance class, after a long while I might add. The discussion of currency crises models I think is interesting, since it is very revealing of the mainstream assumptions about the long run. Typical discussion would imply that in the long run the Quantity Theory of Money (QTM) and Purchasing Power Parity (PPP) hold. PPP means simply that the exchange rate adjusts for differences between the domestic and foreign price levels. Hence, we have that S =P/P*, where the star indicates foreign variable. If in addition we believe with the QTM that the central bank (CB) controls prices by controlling the money supply, then the CB can control the exchange rate indirectly.

In the figure below the 45o line shows the equilibrium levels of the exchange rate (S) as the price level, which is related to the money supply. Now suppose that the central bank fixes the exchange rate at S1 (the graph is based on Dornbusch representation in his classic paper; for now disregard the QQ curve). If the money supply is below the level that corresponds to P1, then the fixed exchange rate is too depreciated for the current stock of money, stimulating exports, discouraging imports, and leading to Current Account (CA) surpluses. In this case, the central bank would accumulate international reserves. The accumulation of reserves leads to increasing money supply and the economy moves to a new equilibrium.

If the central bank follows the rules of the game and it is credible (and the assumptions are also valid, meaning the economy has a tendency to full employment and increase in money supply only affect prices) then the money supply increases/decreases with the CA surpluses/deficits and the system converges to a stable equilibrium. However, if the commitment to the fixed-peg is not credible, and the rules of the game are not followed, then problems might arise. Imagine a situation in which the monetary authority continues to print money, to finance fiscal deficits for example, and the fixed exchange rate would now be below its equilibrium value (below the 45o line). Beyond the equilibrium point the central bank would start losing reserves. At some point, say when the money supply reaches the money supply level compatible with P2, the stock of reserves would be depleted. At this point, the central bank cannot defend the exchange rate anymore and the exchange rate jumps to S2. The Krugman model basically assumed exactly this, with the difference that if agents have rational expectations (perfect foresight in this case), then they would have an advantage to try to speculate against the currency before reserves are exhausted.*

In the model above the currency crisis occurs because the CB does not follow a monetary policy consistent with the fundamentals, that is, prints too much money to finance the government. Although, not immediatly obvious the model above is a simplified version of the Mundell-Fleming (MF) model, in the long run, when prices rather than income is the adjusting variable.In this case, the MF model can be represented with the exchange rate and prices, rather than output, as the adjusting variables. The QQ curve is a downward sloping curve, since higher prices increase money demand (or reduce the real money supply), leading to a higher rate of interest and a more appreciated exchange rate (lower S). Note the QQ curve is just the old LM for an open economy.

Also, because the QTM and PPP hold it must be true that increases in money supply lead to higher prices which lead to a proportional change in the nominal exchange rate, for a given foreign price and foreign money supply. In other words, the 45o degree line which corresponds to the proportional changes in domestic prices and the nominal exchange rate must still hold. We can derive the IS curve too, which would be upward sloping, but it is unnecessary, since if PPP holds then the economy must be in the long run on the 45o degree line.**

Dornbusch's trick, which was considered the first New Keynesian model (featuring both rational expectations and price rigidities), is that the nominal exchange rates adjusts faster than prices, then an increase in money supply would shift the QQ (LM) curve upwards. An increase in money supply reduces the domestic interest rate, leading to a depreciation of the currency. The economy moves from point A to point B. Then as depreciation increases net exports, and a lower rate of interest leads to more investment, there will be excess demand in the goods market, and for an economy that is at full employment, prices would go up. As prices go up, then the economy moves down the new QQ’ curve from point B to C, since with higher prices money demand increases and the rate of interest must increase (less than the initial decrease) causing some appreciation (less than the initial depreciation). At the new equilibrium the exchange rate is more depreciated than at the original equilibrium, but because of the short run rigidity of prices, the exchange rate overshoots its equilibrium value in the short-run. The point was that even if markets were efficient, in the sense that with price flexibility they tend to full employment and to the equilibrium exchange rate (PPP), the use of the exchange rate to deal with shocks might lead to excessive volatility.

There are many problems with the long run MF model (meaning the one solved in the S-P space). The obvious one is the notion that price flexibility leads to full employment, something that Keynes long ago suggested was NOT the case. Although Keynes was aware of the possibility of the system returning to full employment with price flexibility, he suggested that if lower prices had a negative impact on firms that are indebted, then investment would fall. In his own words: "indeed if the fall of wages and prices goes far, the embarrassment of those entrepreneurs who are heavily indebted may soon reach the point of insolvency, — with severely adverse effects on investment." In other words, with price flexibility the IS shifts back, and there is no tendency to full employment. That means that one should stick with the solution of the model in S-Y space, if one wants to introduce the open economy (one such model, without full employment and many other mainstream characteristics is available here).

Alternative (classical-Keynesian, post-Keynesian or whatever you prefer to call them) models would not only emphasize the role of quantity adjustments, but also the the sustainability of the current account (CA), rather than fiscal deficits in the explanation of currency crises. While conventional currency crises models of all generations (including the more heterogeneous 3rd generation models) suggest that at the heart of currency crisis there is a fiscal crisis, post-Keynesians emphasize terms of trade shocks and hikes to foreign rates of interest, highlighting the role of the balance of payments constraint in currency crises. Note that the economy in this view is not at full employment, and, hence the effect of fiscal expansions is not on prices, but on the level of activity. Higher level of income leads to increasing imports and a deteriorating CA. It’s the deteriorating CA and not the fiscal deficits that matter and the CA position might worsen even if the fiscal accounts are balanced. Further, after a currency crisis the central bank hikes the rate of interest, increasing the costs of debt-servicing, and, hence, government spending, at the same time that the recession reduces the revenue, leading to a weakening of the fiscal accounts. In this case, it is the external currency crisis that causes the domestic fiscal crisis. Causality is reversed. My two cents.

* Later models, like Obstfeld's, shown that if the costs of defending the parity are high, for example because in order to preclude the loss of reserves associated with a currency attack, the central bank hikes the rate of interest and pushes the economy into a recession, then there is a chance that self-fulfilling speculation might lead to a crisis.

** The IS curve would be positively sloped and steeper than a 45o line, since depreciation creates excess demand in the goods market. To restore equilibrium, domestic prices would have to increase, though proportionately less, since an increase in domestic prices affects aggregate demand, both via the relative price effect and via higher interest rates.

PS: I had posted before on my course here, were there is a link to Serrano and Summa's critique of the MF model.

Keynes is all you need

From BusinessWeek:

Is there a doctor in the house? The global economy is failing to thrive, and its caretakers are fumbling. Greece took its medicine as instructed and was rewarded with an unemployment rate of 26 percent. Portugal obeyed the budget rules; its citizens are looking for jobs in Angola and Mozambique because there are so few at home. Germans are feeling anemic despite their massive trade surplus. In the U.S., the income of a median household adjusted for inflation is 3 percent lower than at the worst point of the 2007-09 recession, according to Sentier Research. Whatever medicine is being doled out isn’t working. Citigroup (C) Chief Economist Willem Buiter recently described the Bank of England’s policy as “an intellectual potpourri of factoids, partial theories, empirical regularities without firm theoretical foundations, hunches, intuitions, and half-developed insights.” And that, he said, is better than things countries are trying elsewhere.

Read rest here.

On the blogs

For Whom the Wall Fell? -- Branko Milanovic's analysis of the effects in Eastern Europe of the transition to capitalism. Not good, by the way. Few success stories, and mostly associated to commodity booms. Worth reading also his response to Andrei Shleifer's view that the transition was a success.

Trapped in a Recession -- C.P. Chandrasekhar discusses why we are back in a "situation where finance capital is back to profitability and is thriving but the real economy and the rest of the system is mired in recession." In one word, austerity.

Obituary: Frederic S. Lee (1949-2014) -- Tae-Hee Jo has published a nice obituary with more biographical detail than previous ones.

IMF Response to the Financial and Economic Crisis -- Independent Evaluation Office (IEO) report on the IMF's role during the Great Recession. They suggest that: "The IMF’s record in surveillance was mixed. Its calls for global fiscal stimulus in 2008–09 were timely and influential, but its endorsement in 2010–11 of a shift to consolidation in some of the largest advanced economies was premature." I am more critical, as you know, but it is good that their evaluator noticed that the IMF has pushed for austerity too soon.

PS: And yes the last one is not really a blog post. But it's related to a previous blog post of mine. ;)

Foster and Yates on Piketty & The Crisis of Neoclassical Economics

Michael D. Yates kindly asked me to post a link to his new MR article, co-authored with John Bellamy Foster, on Piketty & the current state of mainstream economics; comments & feedback are welcomed.

Not since the Great Depression of the 1930s has it been so apparent that the core capitalist economies are experiencing secular stagnation, characterized by slow growth, rising unemployment and underemployment, and idle productive capacity. Consequently, mainstream economics is finally beginning to recognize the economic stagnation tendency that has long been a focus in these pages, although it has yet to develop a coherent analysis of the phenomenon. Accompanying the long-term decline in the growth trend has been an extraordinary increase in economic inequality, which one of us labeled “The Great Inequality,” and which has recently been dramatized by the publication of French economist Thomas Piketty’s Capital in the Twenty-First Century. Taken together, these two realities of deepening stagnation and growing inequality have created a severe crisis for orthodox (or neoclassical) economics.

Read rest here.

For other posts on Piketty, see here, here, here, here, here, and here.

The IMF, Austerity and the Ebola Crisis in West Africa

Recently I posted (and here) on the relative persistence of IMF policies on the fiscal front. As noted by Rick Rowden, the IMF has, at least temproraily, lifted its ban on fiscal expansion in West Africa, as a result of the ebola crisis. Christine Lagarde, the Fund's Managing Director said:

"It is very rare for the IMF to say that, but on this occasion I will say it: It is good to increase the fiscal deficit when it's a matter of curing the people, of taking the precautions to actually try to contain the disease. The IMF doesn't say that very often."

No they don't. Rick explains in his Foreign Policy piece how the IMF has an impact on heath outcomes with its austerity policies. He says:

"the harmful effects of IMF policies on health systems are not direct; it's not as if the IMF comes in and directly tells a country to spend less on public health. Instead it's a two-step process: First the IMF policy targets constrain overall national spending levels, and this then limits the spending available for long-term public investment, including for the health infrastructure. Consequently, chronic and sustained underinvestment in public health infrastructure has become the norm in many countries, year after year, over the last few decades."

And yes, Rick knows that the IMF has not caused the ebola crisis with its austerity policies, it has just made them worse. He concludes that:

"But if the international community is serious about addressing chronic under-investment in the public health systems in these countries, it will also have to revise the obvious shortcomings of IMF fiscal and monetary policies."

I had written on the IMF and the use of aid for health spending in relation to the HIV/AIDS crisis in Africa. The paper was published by the United Nations Development Program's Poverty Center and is available here.